CEG GSB 703 Mini Case Assignment #1 Adam Ohanesian Email: Adam. [email protected] edu Table of Contents I. Intended roles of each of the institutions and intermediaries. a. Venture Capitalists b. Investment Bank Underwriters c. Sell-Side Analysts d. Buy-Side Analysts and Portfolio Managers e. Accounting Profession f. FASB II. Properly aligned incentives g. Venture Capitalists h. Investment Bank Underwriters i. Sell-Side Analysts j. Buy-Side Analysts k. Portfolio Managers l. Changes III. Internet Stock Market Bubble Responsibility m. My opinion n. Venture Capitalists proof . Investment Bank Underwriters proof p. Sell-Side Analysts proof q. Buy-Side Analysts proof IV. Costs r. Investors s. Employees t. Companies 1. What is the intended role of each of the institutions and intermediaries discussed in the case for the effective functioning of capital markets? The role of the venture capitalist is to provide capital for companies in their early stages of development. They expect a very high rate of return on their investment which is done by selling their stake to the public through an IPO or to another company in a trade.
They screen good business ideas and entrepreneurial teams from bad ones. Also, they help companies until they reached a point where they are ready to face the public markets after an IPO. The role of the investment bank underwriter is to provide advisory financial services, help companies price their offerings, underwrite the shares, and introduce them to investors. The role of the sell-side analyst is to publish research on public companies, make buy or sell recommendations on stocks, and work with the buy-side analysts providing research before the company goes public.
The role of the buy-side analyst is to conduct industry research, communicate with the company management team, create earnings estimates, conduct valuation analysis, and rate company stock prices as “buy” or “sell”. The role of the portfolio manager is to actually manage money under recommendations of the analysts. The role of the accounting profession is to audit the financial statements of public companies to verify the accuracy and make sure there is no fraud.
They also provide an opinion statement attached to the companies public filings stating if they are satisfied or unsatisfied. The FASB (Financial Accounting Standards Board) is an independent regulatory body in the United States who establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information. 2. Are their incentives aligned properly with their intended role? Whose incentives are most misaligned?
Venture capitalists main form of compensation is a large share of profits which is typically 20%. Also a low fee based on assets under management. Investment bank underwriters are paid on a commission basis on the amount of money the company raises in its offering which is typically 7%. The sell-side analysts are partly compensated based on the amount of trading fees and investment banking revenue the assist the firms generate through their research. The buy-side analysts are compensated based upon how well their stock recommendations do.
Lastly, the portfolio managers are compensated based by the performance of their funds relative to an appropriate bench mark return. I feel the venture capitalists should get more than the typical 20% as they are the ones supplying the funding for the company. Without the assistance of the venture capitalists the company may not be able to develop properly or as they wish. Also the investment bank underwriters could get a little more than 7% since they are the people who actually write the shares and present them to potential investors.
The two analyst types and portfolio managers are aligned properly I feel. 3. Who, if anyone, was responsible for the Internet stock bubble? In my opinion, there was not one group or person responsible for the Internet stock bubble but a combination of groups partially responsible. After reading the case, I feel there are four groups responsible and I will explain. The venture capitalists are partially responsible because they were influenced by the market, knowingly investing in and bringing public companies with suspect business models.
Some even say the venture capitalists brought companies public too early. The investment bank underwriters are also partially responsible because these banks are supposed to have experts with highly regarded advice. So how could they pick such duds of companies? The sell-side analysts had buy ratings on companies that eventually had fallen dramatically in price. While the buy-side analysts over valued companies and invested in them regardless. 4. What are the costs of such a stock market bubble? As a future business professional, what lessons do you draw from the bubble?
The costs of the stock market bubble I came away with were investors lost a lot of money if they did not sell the stock before the value decreased. Employees lost jobs as profits decreased and companies had to down size. Also, companies going out of business were a cost. As a future business professional I drew to know the value of what you are investing in. Make a educated, researched decision before taking action. Finally, do not over value your business, be realistic. Reference Material Sources Text book: Business Analysis & Valuation Using Financial Statements, Palepu & Healy, 2008, Thomson Sout-Western.